Goldilocks and the too small, too big problem of Agroenterprise investment
With over 2 billion rural poor involved in agriculture for both income and food, lending to small farmers as a way to increase global food production, and alleviate poverty seems like a win-win situation for both the private and the public sector. Yet lending to dynamic, emerging agro enterprises in developing countries has proved problematic, demanding a mixture of old and new tools, and a completely different way of assessing and understanding risk, partnerships, and business development services.
What are the financing needs of rural small and medium enterprises (SMEs) and why is it so hard to get it to them?
The social, environmental, and economic benefits of investing in small scale agriculture are wide reaching and have resulted in a flurry of activity from donors, private investors, non-profits, and governments. Innovative new partnerships have emerged to help mitigate risk and encourage the development of financial tools. Despite these positive developments, a large portion of dynamic rural enterprises in the developing world are still without access to capital for scaling up, creating value, or for making significant improvements to their enterprise. With so much potential and many investors clearly seeing the potential ROI (2 billion more individual reaching the food consumption levels of the middle class by 2030!), why isn’t financing easier to access for rural enterprises?
Rural Enterprises and Entrepreneurs
A rural entrepreneur is an individual has successfully moved into market-oriented agricultural based activities and is poised to serve as an enterprise growth point for their community or region. The growth of rural enterprises means leveraging significant and sustained positive change for an important number of small farm families, agricultural day laborers, sorting and packing employees and others. Lack of capital at this crucial growth stage in their businesses can often force them to apply survival strategies (i.e. non-transparent business practices such as delayed or reduced payments to suppliers) that have negative consequences both for their enterprises and the network of rural poor who depend on them.
Not big enough, not small enough
Most rural entrepreneurs have financing needs ranging from USD $10,000 to under USD $1 million. This population faces significant barriers to accessing funding because they are too large for microcredit (and are often successful graduates of microcredit programs) but too small or marginal for commercial credit from banks or from governments (who typically fund enterprises in excess of USD $1 million). Income diversification too tends to be a problem for these Small and Medium Enterprises (SMEs). Generally for microfinance, lending occurs in urban or semi-urban areas where individuals have other methods of income or the opportunity that can be leveraged if needed. Larger organizations able to take on high commercial credit (as mentioned above), tend to have collateral and other forms of equity that help lenders come to terms with risk. The lack of a ‘Goldilocks’ strategy for rural entrepreneurs means that they fall through the cracks. Recent work has called this the missing middle of rural finance.
Source: Practical Action Publishing
The missing middle for SME financing is further widened by three other factors:
- Transaction/administration costs are extensive. Because of great inherent risk (see a past post), SME loans are high maintenance, requiring constant monitoring and evaluation.
- Taking equity is not always a clear option. Equity in large scale operations (like those needing funding over 1 million) tend to have equity arrangements to leverage risk. Small farmer organizations (either owned cooperatively or privately), which are producing the quality and quantity needed for large companies often have a decentralized ownership model, complicating the ability for an investment firm to measure and legally obtain equity.
- Type and time exposure: While microfinance tends to lend to individuals in short spurts (about a year) and venture capital tends to be extended to more savvy enterprises with decent scale, scope and ROI potential for a disclosed period of time, small farmers need sizeable funding for the long and the short term, often in enterprise development where risk is difficult to assess. This approach of patient capital is still rare in the rural finance field.
- Investors don’t have a clear exit route. Because the financing and the managerial skills needed for these types of investments are so specialized, clear exit routes for investors to sell their stakes and realize a profit for capital recycling often doesn’t exist.
Based on these factors, two clear investment strategies have emerged – both of which are incompatible with lending to SME’s.
- A smaller number of bigger investments. If one enterprise fails then other large investments will likely carry the financing organization without incurring too many transaction costs or requiring expensive monitoring and assistance. Microfinance, on the other hand, does the opposite.
- A larger number of simpler, smaller investments*. With some exceptions, microfinancing tends to take this route by employing a strategy of investing low cost transaction loans over a short period of time that are simplistic, specifically targeted, and generally have lower associated risk. None of these usually apply to rural entrepreneurs.
Hope for the missing middle in agricultural finance?
Simply put – yes! Solutions and tools will emerge from a concerted approach through private and public sector partnerships, the likes of which are already occurring . Knowing what the gap entails, improving infrastructure and organizing farmer organizations to create effective demand for lending services will yield results. Knowing why the old methods of lending and capitalization aren’t working for SME’s and building a new model with agriculture in mind is the first step.